Its been almost three years (2021) since I bought my first house and with interest rates being significantly higher today than in 2020-2021, it is a fundamentally different market for home buyers. For the purposes of this article, I will deep dive into a lesser known financial tool individuals with a well diversified moderate to low risk taxable portfolio can leverage for either a down payment or create a unique situation to make a cash offer on a property while also covering the basics.
Different times
To put things into perspective, if I were to put the same 20% down for the same price of home (which has appreciated 10% in value since purchase) my 15yo fixed rate mortgage would cost atleast 33% more per month or 48% more if I were on a 30yr fixed.
With interest rates being as high as they are, it does limit in one’s ability to buy a house if they are going to be taking a mortgage. Feel free to leverage the calculator to see what your mortgage can look like to see what fits your budget.
Minimum Requirements
Buying a house as a primary residence is an emotional decision for most and there are a few requirements one should be aware of from a financial perspective. Since the Great Depression, lenders have become very strict in underwriting loans and it is important to meet their requirements if you borrow money from them.
- Downpayment: anything less than 20% will result in a PMI but the lowest you can realistically put down is 3.5%
- Credit Rating: you should ensure you have a good credit score to secure the most favourable rates
- Debt-to-Income Ratio: lenders typically want this as low as possible and the amount of debt you have can limit your purchasing power.
- Closing costs: keep atleast 1-5% of your purchase price to cover closing costs which might include rate buy downs.
- Cash/Investment paper trail: lenders want information on how you plan on making your down payment – the source and require statements to support you acquired the money legally.
Coming up with a down payment
Savings
99% of individuals or families looking to buy a house go the traditional route – save up over a period of time (cash equivalents) which while mostly secure, can take a long time but also means it has a lost opportunity cost. If your purchase timeline is less than 6 months and you’re actively looking to put down an offer – this makes a lot of sense for most people.
Taxable brokerage
The alternative, is to invest from an early age and grow those contributions – which unfortunately very few people actually do. However, if you know you will be a buyer at some point in the future, this makes the most sense as your money has the opportunity to grow as the economy grows subject to market risks ofcourse. This can be leveraged and its a lesser known secret the rich/high net-worth individuals apply – which I will be covering in this article.
Roth IRA
Another source of funds come from one’s Roth IRA – I personally do not think this is a good idea as you are stealing from your future self. However, it is important to be aware that there is an option for a first time home buyer (if they meet certain conditions).
As a first time buyer, you can withdraw earnings penalty-free (but not tax-free) from your Roth IRA before the account is five years old (and before age 59½). If you take out earnings for a first-time home purchase after five years, you will owe no penalty or taxes (on gains), even if you are under 59½. You are limited to a life-time amount of $10,000 – so it clearly isn’t a lot – but it allows you to bridge the gap – not that I think it is a wise financial decision.
Securities Based Line of Credit
Recently, all-cash offers have become increasingly common in high worth areas and it always boggled my mind how people were making these offers. I always assumed it either involved sitting on a lot of cash – losing opportunity cost over time, or selling a big chunk of their portfolio – which would result in massive capital gains tax.
Enter: SBLOC or PAL (pledged asset line). These are essentially a “line of credit” issued against your taxable investment account that allow you to access cash by borrowing against the assets in your investment portfolio as collateral. It is also worth noting, interest rates tend to be lower than a traditional personal loan as you are essentially borrowing against your existing assets – which the bank can essentially sell at any time to cover the position.
Unlike a traditional term loan, most types of SBLOCs do not have a defined maturity or fixed repayment schedule – you essentially can make interest only payments for the duration you borrow the loan and pay off the principal at any time hence offering much more flexibility. SBLOCs can many a times offer better rates than a traditional mortgage too or serve as a great bridge loan when you want to sell your current home and purchase a new one.
Money from an SBLOC can be used for virtually anything, except to purchase or trade more securities. Banks will assess the risk-profile of your portfolio and accordingly limit how much you can borrow. Rates also often vary bank to bank and in my research, I found Interactive Brokers (IBKR) to have the lowest rates (although they call them margin rates).
So why should one consider SBLOCs? As you grow your taxable portfolio account – selling your assets can lead to high taxes (depending on short & long term). A $500K balanced, moderate-low risk portfolio will essentially enable you to take out a LoC enough for a down payment in a medium to high cost of living city or an all-cash offer on a starter home in a low cost of living city.
Scenario A: Down Payment
If you are buying a $500K home and take a LoC of $100K against your $500K portfolio and finance the rest, you can either keep making interest payments on your LoC amount and pay off the borrowed principal based on ordinary income (including bonuses, stock grants) or any windfalls or refinance the $100K equity into a secondary mortgage which may have a slightly higher rate than the existing mortgage. While it may seem counter-intuitive, mathematically, you save on the taxes vs paying capital gains (assuming $100K is gains),
Scenario B: All cash
This is where a SBLOC is really worth considering and creates real monetary value. If want to buy a $500K house and your portfolio is worth $800K, you can take out an SBLOC for $500K, make an all-cash offer potentially making your bid more favorable to a seller and closing on the house faster (as with banks it can take upto 30 days).
After you buy the house, you have 100% equity and you can refinance upto 95% of the house placing a new mortgage against the property. The money you receive from the bank pays off the principle you borrowed in the LoC and you cover any interest payments accrued for the short amount of time + atleast the remaining 5% LoC. You will then make mortgage payments as normal – maybe with a slightly higher interest rate than if you just did a traditional mortgage but you saved tens if not hundreds of thousands in taxes (depending on your state taxes and income levels).
The second scenario is what I have realized a lot of high net worth individuals do when buying properties and/or starting a business. Using an SBLOC, you can get the cash you need, wait until your investments reach long-term capital gains status, then sell them to repay the loan or provide leverage. The tax-savings can significantly outweigh the cost of interest on the loan especially for those who’s income is tied to stock options or RSUs.
SBLOC rates are typically tied to a floating or benchmark rate such as SOFR / LIBOR + %points by the bank. Here are the reference rates for IBKR: https://www.interactivebrokers.com/en/trading/margin-benchmarks.php
As you can see, based on a Benchmark Rate of 5.33% (as of 4/22 – subject to change daily), the blended rate on $500K borrowed is 6.43% vs 8% on a conventional 30yr mortgage.
Conclusion
This article is purely for educational purposes and I am not a certified financial professional so please keep in mind there are risks with SBLOCs – if the market falls 30% – banks will either ask you to fulfill the margin requirements or will trigger a sale of your assets causing taxable events. SBLOCs are NOT viable for everyone however, it is useful to be aware of something that exists as it can be useful in the future.
